Fed Unlikely to Remove Its Economic Stimulus Just Yet

By

Jon Hilsenrath

Updated March 7, 2011 12:01 a.m. ET

Federal Reserve officials have grown more confident that a self-sustaining economic recovery is taking root in the U.S., but they want to see more evidence before they seriously consider how and when to pull back the enormous amounts of stimulus they pumped into the financial system.

ENLARGE

Fed Chairman Ben Bernanke
Reuters

So when officials gather for their next policy meeting March 15, they are likely to decide to continue a $600 billion Treasury securities purchasing program. They are also likely to maintain a commitment to keep short-term interest rates near zero for an "extended period."

Barring a surprising turn in the economy or inflation, it seems increasingly likely that the securities purchase program, known by some as quantitative easing, is likely to end in June as scheduled.

Discussion inside the central bank's Federal Open Market Committee might then turn toward how and when to tighten policy, either by raising short-term interest rates or reducing its securities holdings, but it could be months before it acts.

Top Fed officials believe the securities purchase program has been effective and has helped improve the economy's performance in recent months. Some want to see how the economy performs later in the year without it. The recovery, in this view, might be likened to a child riding a bicycle with training wheels. How will it perform when the added support comes off?

Trading in the federal-funds futures market, where investors make bets on when the Fed will raise or lower interest rates, suggests they expect the central bank to start raising short-term interest rates in early 2012. The federal-funds rate, an overnight lending rate between banks which the Fed controls, is now close to zero.

In testimony to Congress last week, Fed Chairman Ben Bernanke laid out three criteria that would dictate his decision on tightening monetary policy: He wants to be sure that a sustainable recovery is at hand, that employment is clearly improving and that inflation is moving toward the Fed's long-term objective of 2%.

The employment report released Friday was the latest piece of evidence that the economy is making progress on these fronts. In the past three months, private payroll employment has increased on average by 152,000 per month, the best performance since early 2007. The unemployment rate, at 8.9%, is already at the low end of the Fed's projection for 2011.

"We have seen increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold," Mr. Bernanke said in his testimony.

The hawks on the Fed's policy-making committee who tend to worry about inflation and be less supportive of easy-money policies, aren't yet pushing very hard for a change of course either, another reason why policy is likely to remain steady for now. In 2008, when commodities prices started soaring, presidents of some regional Fed banks urged the Fed to start tightening. This time, as oil prices surge again, they have been relatively quiet.

"I think that's quite likely, that this ends up being a passing event," Richmond Fed President and inflation hawk Jeffrey Lacker said of the rise in oil prices, in an interview last week.

Another counterweight to inflation that has drawn the Fed's attention is the strong growth in labor productivity—or output per hour worked—in recent quarters. These gains are holding down labor costs, which are a much bigger factor in inflation than commodity costs.

The Fed's approach contrasts with that of many central banks elsewhere in the world. European Central Bank President Jean-Claude Trichet, for instance, last week signaled the ECB could tighten soon.

One option that Fed officials have with the securities purchase program is to taper it off gradually—meaning purchase the full $600 billion but over a longer stretch of time—an approach they chose with their mortgage purchase program last year.

Though the idea of tapering has received some attention on Wall Street of late, officials seem unlikely to want to follow that course this time unless they have some evidence that ending the program all at once in June might disrupt the functioning of the Treasury market.

In comments last month, Brian Sack, the head of the New York Fed's markets desk, said the program wasn't disrupting market functioning.

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